External sector: BoP, exchange rate, FDI/FPI & trade policy

The Balance of Payments framework

The Balance of Payments (BoP) is the systematic record of all economic transactions between residents of India and the rest of the world over a financial year, compiled by the Reserve Bank of India under the IMF's Balance of Payments and International Investment Position Manual (BPM6). By construction the BoP always balances; what candidates must track is the composition.

The current account

The current account records trade in goods (the merchandise balance), trade in services (the invisibles surplus that India's IT and software exports generate), and net transfers—chiefly remittances. India is the world's largest recipient of remittances, crossing USD 125 billion in 2023-24 per World Bank estimates. India persistently runs a merchandise trade deficit (imports of crude oil, gold and electronics exceed exports), partly offset by a services and remittances surplus. The residual is the Current Account Deficit (CAD). The CAD peaked at 4.8% of GDP in 2012-13, triggering the Taper Tantrum rupee crisis of mid-2013; it narrowed to roughly 0.7% of GDP in 2023-24.

The capital and financial account

This records cross-border investment: Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), External Commercial Borrowings (ECBs), NRI deposits and banking capital. A CAD must be financed by net capital inflows; the difference accrues to the change in foreign exchange reserves. India's reserves crossed USD 700 billion in September 2024, among the largest globally, providing an import cover the RBI targets at well above the conventional adequacy benchmarks.

Identity to memorise

Current Account + Capital Account + Errors & Omissions = Change in Reserves. A current account deficit financed by stable FDI is benign; one financed by volatile FPI is a vulnerability—the distinction the 2013 episode burned into policy memory. Note the terminology trap: the Balance of Trade covers goods only, while the current account balance adds services and transfers. Examiners routinely test whether a candidate confuses the two.

Convertibility

The rupee is fully convertible on the current account (since August 1994, under IMF Article VIII obligations) but only partially convertible on the capital account. The roadmap to fuller capital-account convertibility was charted by the two Tarapore Committees (1997 and 2006), whose phased recommendations remain only partly implemented—deliberately, to preserve insulation from hot-money reversals.

Exchange-rate regime

India operates a managed float (a 'dirty float'): the rupee's external value is market-determined, but the RBI intervenes in the spot and forward markets to curb excess volatility, not to defend a target level. This succeeded the rigid peg dismantled during the 1991 balance-of-payments crisis, when India pledged gold to the Bank of England and the Bank of Japan and the rupee was devalued in two steps on 1 and 3 July 1991 (the LERMS—Liberalised Exchange Rate Management System—followed in 1992 before unification in 1993). A depreciating rupee makes exports cheaper and imports dearer; the REER (Real Effective Exchange Rate) is the inflation-adjusted, trade-weighted index used to judge whether the rupee is over- or under-valued.

FDI versus FPI

The distinction is high-yield. FDI is a lasting management interest—the threshold is 10% or more of equity—and is regulated under the FEMA, 1999, with policy issued by the DPIIT and the consolidated FDI Policy. FDI enters through the Automatic Route (no prior approval) or the Government Route (approval needed). Post-2017, the FIPB was abolished; approvals now run through the administrative ministries. Sectoral caps illustrate the regime: defence 74% automatic / 100% government, insurance 74%, telecom 100%, while sectors like atomic energy and lottery/gambling are prohibited. After the COVID-19 onset, Press Note 3 (April 2020) mandated government approval for investments from countries sharing a land border with India—a measure aimed at China.

FPI is investment in listed securities below the 10% threshold; it is regulated by SEBI under the FPI Regulations, 2019. FPI is liquid and volatile—the 'hot money' that fled during the 2013 Taper Tantrum and again in 2018 and 2022. India's inclusion in the JP Morgan GBI-EM index from June 2024 marked a structural channel for debt FPI inflows.

Trade policy architecture

India's trade is governed by the Foreign Trade (Development and Regulation) Act, 1992, operationalised through the Foreign Trade Policy (FTP) 2023, administered by the DGFT. The FTP 2023 replaced the MEIS (found WTO-inconsistent in a 2019 US dispute) with the RoDTEP scheme (Remission of Duties and Taxes on Exported Products), alongside SEZs, EPCG and Advance Authorisation. India is a founding WTO member (1995) and binds tariffs under the GATT; it is not a party to the RCEP, having withdrawn in November 2019.